Five Things to Know: Digital Digest January 2023
The latest State Street Digital Digest focuses on the transition digital finance must undertake to go from a cryptocurrency “Wild West” to a new frontier for the investment industry, where trust, security and regulation allow institutions to take part with confidence. Our latest Digital Assets and Investment Study shows that institutions are aware of the advantages digital infrastructure can confer on their operations, and on behalf of their clients and members. We share the results of the study, along with the industry’s reaction.
The FTX bankruptcy has shaken trust in crypto and digital exchanges. This edition of the Digital Digest explores the efforts to regulate the nascent crypto industry and market reactions. Finally, we take an in-depth look at effective custody of digital assets, which relies on trust and security.
1. Interest in digital assets is moving away from crypto
Results of the 2022-2023 State Street Digital Assets and Investment Study reveal that decentralized asset tokens, including tokenized versions of traditional asset classes, were the digital asset type that respondents (39%) felt would add the most value to their portfolios by investing directly. Cryptocurrencies were second (24%), followed by NFTs (16%). Only 9% of respondents preferred investment into firms providing the technology behind digital assets. A potentially surprising 11% of respondents claimed to be pioneers in “using code-based smart contracts to trade tokenized versions of traditional assets on a distributed ledger/blockchain,” and nearly a quarter more (22%) said they were ready to do so, but had not yet. Meanwhile, 40% said they were not able to do this, but were putting strategies and relationships in place to do so.
2. Industry split on the speed of the digital revolution, but expect efficiency gains
Respondents saw a variety of ways that digital assets and their underlying technology could work to the benefit of their organizations, with a third or more citing distribution, asset issuance, asset servicing and smart contract generation among the most important services they would like provided in a digital finance environment. But improved operational efficiency and reduced operating costs were a common theme in the ways they expected these areas to improve their businesses. However, respondents were split on the imminence of mainstream digital tokenization and trading, with many believing it is still a decade or more away.
3. Growth of Bitcoin makes falls in its value increasingly systemic
The main lesson from 2022 was not that Bitcoin is a volatile asset; that much has been apparent for years. It was that even with its rapid growth in size – reaching a market capitalization of $1.2 trillion in November 2021 – it has remained volatile and potentially systemic. So while the large percentage monthly falls in Bitcoin over the summer of 2022 were not unusual, the destruction in market capitalization was. While direct estimates and comparisons should be taken with a healthy grain of salt, the loss in Bitcoin market cap appears to be on par with the collapse of Lehman Brothers and the LTCM collapse back in 1998, even adjusting for inflation.
4. FTX collapse highlights risks inherent in decentralized finance networks
While the crypto market was developed with aspirations of eliminating perceived exclusionary financial intermediaries, what has been created is a marketplace that relies on powerful, vertically integrated intermediaries in the form of exchanges, custodians and asset managers. Unlike traditional financial institutions, however, the crypto intermediaries are in large part not subjected to a regulatory framework designed to ensure investor protection, segregation of proprietary and customer assets, or a control framework designed to ensure prudent business practices – the net effect of which is to increase consumer risk. With the recent fall of FTX, however, regulators globally are accelerating efforts to introduce appropriate regulation that will hopefully address these systemic issues.
5. But decentralization still means a fundamentally different asset custody model
We want to provide a model that we can be convinced offers a level of safety and robustness that our clients expect from us, but you have to balance this with the fact that a crypto asset fundamentally operates in a different market structure, which is decentralized. A big part of what an organization like ours can bring is providing transparency around these new dynamics.
To see more results from the State Street Digital Finance Study, please contact your State Street relationship manager, Luke Brereton, Head of Client Engagement, State Street Digital, or the author of this article, James Redgrave.